1. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. MONOPOLY MONOPOLY Chapter 12

2. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-2 Today’s lecture will : Summarize how and why the decisions facing a monopolist differ from the collective decisions of competing firms. Explain why MR = MC maximizes total profit for a monopolist. Determine a monopolist’s price, output, and profit graphically and numerically.

3. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-3 Today’s lecture will: Show graphically the welfare loss from monopoly. Explain why a price-discriminating monopolist will earn more profit than a normal monopolist. Explain why there would be no monopoly without barriers to entry. Discuss three normative arguments against monopoly.

4. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-4 Definition of Monopoly Monopoly is a market structure in which one firm makes up the entire market. Barriers to entry into the market prevent competition. There are no close substitutes for the monopolist’s product.

5. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-5 Determinimg Equilibrium Price and Quantity

6. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-6 Equilibrium Price and Quantity MC $36 30 24 18 12 6 0 -6 -12 Price 12345678910 D MR The monopolist’s price is $24 MR = MC at approximately 4 units Quantity

7. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-7 Comparison of Monopoly and Pure Competition 20.50 $36 24 12 0 Price MC 1234 5.17 678910 D MR Monopolist price $24 (MR=MC) Competitive Price $20.50 (P=MC) Monopoly output is lower and price is higher than in perfect competition. Quantity

8. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-8 Finding a Monopolist’s Output, Price, and Profit Price ATC MC Quantity PMPM 0 MR QMQM CMCM A B D Monopolist produces output Q M where MR=MC. Monopolist charges price P M from A on the demand curve. Profit is P-ATC (A-B) times total output, Q M. Profit

9. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-9 Breaking Even Price MC Quantity PMPM 0 MR D QMQM ATC Produce Q M where MR = MC Price (P M ) = ATC Profit = 0

10. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-10 Minimizing Losses Price ATC MC Quantity0 MR D QMQM Loss PMPM CMCM B A Price (P M ) < Cost (C M ) Produce Q M, where MR = MC. Loss = C M P M BA

11. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-11 Welfare Loss A C PMPM D B MC MRD QMQM PCPC QCQC 0 Price Quantity A: opportunity cost of diverted resources B and D: welfare loss or deadweight loss C: transfer from consumer surplus to monopolist

12. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-12 Price Discrimination Monopolist charges different prices to different individuals.  Consumers with less elastic demands are charged higher prices.  Consumers with more elastic demands are charged lower prices. Price discrimination increases output and profits.

13. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-13 Examples of Price Discrimination Movie discounts to senior citizens and children. Airline discounts for Saturday night stayovers. Cars are seldom sold at list price. Tracking consumer information and pricing accordingly.

14. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-14 Barriers to Entry Natural Ability  A firm is better at producing the good than anyone else. Economies of Scale  Natural monopoly - a single firm can produce at a lower cost than can two or more firms. Government-Created Monopolies  Patents, licenses, and franchises

15. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-15 Natural Monopoly 0Quantity Average Cost C3C3 C2C2 C1C1 Q⅓Q⅓ ATC Q½Q½ Q1Q1 One firm producing Q 1 has average cost C 1. If two firms share the market, each produces Q 1/2 and has average cost C 2. Three firms each producing Q 1/3 have average cost C 3.

16. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-16 Loss Natural Monopoly Average Cost A natural monopolist produces Q M and charges P M and earns a profit. QMQM QCQC 0Quantity MR D PMPM PCPC C CMCM ATC MC Profit If the government regulates a competitive solution where P=MC, the monopolist charges P C and produces Q C for a loss..

17. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-17 Normative Views of Monopoly Monopolies are unjust because they restrict freedom. Monopolies transfer income from “deserving” consumers to “undeserving” monopolists. Monopolies cause potential monopolists to waste resources trying to get monopolies.

18. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-18 Government Policy and Monopoly: AIDS Drugs A few companies have patents for AIDS drugs that enable them to charge high prices because demand is inelastic. Policy Options  Government regulation where price = marginal cost benefits society, but discourages research.  Government purchase of the patents and allowing anyone to produce the drugs so their price = marginal cost is expensive for taxpayers.

19. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-19Summary Monopoly is a market structure, protected by barriers to entry, in which a single firm produces a product for which there are no close substitutes. A monopolist maximizes profit or minimizes losses where MR=MC. To determine a monopolist’s profit or loss:  Find output where MR=MC.  Determine price and ATC at that output.  Profit or loss = (P – ATC) * Q.

20. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-20Summary Monopoly output is lower and price is higher than in competitive markets. Because monopolies reduce output and charge P > MC, monopolies create a welfare loss for society. A price-discriminating monopolist earns more profit than a normal monopolist by charging a higher price to those with less elastic demand and a lower price to those with more elastic demand.

21. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-21Summary In order to discriminate a monopolist must:  Identify and separate groups of customers with different elasticities of demand.  Limit their ability to resell its product between groups. Three important barriers to entry are:  Natural ability  Increasing returns to scale  Government restrictions

22. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-22Summary Natural monopolies exist in industries with strong economies of scale, so it is more efficient for one firm to produce the entire output. In a natural monopoly the competitive outcome where P=MC results in losses. Normative arguments against monopoly are:  Monopolies are inconsistent with freedom.  Distributional effects of monopoly are unfair.  Monopolies encourage people to waste time and money trying to get monopolies.

23. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-23 Output PriceTotal Marginal Marginal AverageProfit Revenue Revenue Cost Total Cost 0 $20______ ----- ----------______ 1 18 ______ _______ $ 7$17 ______ 2 16 ______ ______ 5 11 ______ 3 14 ______ ______ 6 9.33 ______ 4 12 ______ ______ 12 10 ______ 5 10 ______ ______ 15 11 ______ 10 Review Question 12-1 Given the following demand and cost information, complete the table and find the profit-maximizing price and output. $ 0 18 $-10 50 48 42 32 18 14 6 2-5 8 14 10 1

24. McGraw-Hill/Irwin Copyright  2008 by The McGraw-Hill Companies, Inc. All rights reserved. 12-24 Review Question 12-2 Show the equilibrium output, price, and profit from question 12-1 on a graph. Price Profit = $14 $20 15 10 5 Quantity 12345 14 MC D ATC MR MR = MC between 3 and 4 units, so the monopolist maximizes profit at Q = 3 and P = $14 Profit = (P-ATC)*Q Profit = (14-9.33)*3=$14 9.33